Q3 Rail Recap: The Good And Not So Good

With the railroads' third-quarter earnings releases over and done, it's time to take a look at who the "winners" and "laggards" were in Q3.

For commodities, the answer might be looking at North American rail volumes in the third quarter. Grain is one obvious "winner." U.S. grain volumes were up 27.8% in September and 25.5% in October, according to the Association of American Railroads, while Canadian Pacific CP and CN CNI reported record grain movements over the last several months. Potash, which is used for fertilizer production, has also seen increased activity. 

Other winners have included intermodal, with volumes up year-over-year. Although trade uncertainties had put pressure on intermodal last year, e-commerce has helped to boost volumes as consumers have had to stay home because of the coronavirus, according to Jeff Windau, senior equity analyst for Edward Jones. 

"The rails have been really able to gain from that," Windau said. 

A positive housing market has also supported intermodal and lumber volumes, he said.

Meanwhile, low oil prices and oversupply have challenged energy products and frac sand, while automotive volumes have a less clear trajectory because although auto sales have been rebounding tremendously, they aren't doing as well as they could be for some rails, Windau said. That could be partly due to plant shutdowns, which have resulted in less product to move.

Who are the winners operationally?

In terms of individual railroads, the companies that could be perceived as winners are those that are further along in their implementation of precision scheduled railroading (PSR), an operating model that seeks to streamline operations. PSR has helped the railroads improve their operating ratios, which is a company's operating expenses as a percentage of a company's revenue. A lower operating ratio can imply improved financial health.

To that regard, Edward Jones has buys for CSX CSX, Union Pacific UNP and CP, and it has holds for Norfolk Southern NSC and CN. The firm doesn't cover privately held BNSF BRK or Kansas City Southern KSU.

Looking ahead, tight trucking markets could offer some opportunities for the railroads because the railroads have been improving their service and there are cost advantages for longer hauls, Windau said. The Canadian railways also have some advantages over the U.S. counterparts because they can go higher speeds and they have easy access to the U.S. Midwest markets via Detroit and Chicago, he said. 

Meanwhile, FreightWaves market commentator Jim Blaze sees the railroads' attempts to lengthen trains as one of the winners of the third quarter. Longer trains increase productivity even amid a global health pandemic, although the question is how much longer can the trains go if the sidings don't go longer themselves. 

"Truckers can't do that. … That to me is one of the reasons why the six Class Is have lower operating ratios. They're continuing to reduce unit costs against labor costs," Blaze said. 

Blaze compared the wesern U.S. railroads against each other and did the same for the eastern U.S. railroads. 

BNSF appears to be willing to adjust its price to gain market share, while Union Pacific (UP) appears to be more focused on pricing and so it's not gaining as many volumes as BNSF, Blaze said.

CSX has been performing better because it has matured in its deployment of PSR, while Norfolk Southern is more of an intermodal carrier but is still working on implementing PSR, he said. And both carriers need to replace coal traffic, which is facing a systemic decline.

Meanwhile, the strikes in Mexico have dampened Kansas City Southern's (KCS) outlook, although KCS' Mexican franchise is the highest growth potential overall, Blaze said.

But are the winners really winners and the laggards really lagging?

Although higher rail volumes and lower operating ratios might appear to look like winners, there are some complexities underlying the winners. For instance, Canadian grain producers told FreightWaves that the railways can't haul all the grain volumes that could be hauled because grain producers compete with other commodities for trains.

"There's a lot left on the table," said Greg Northey, vice president of corporate affairs for Pulse Canada, with members that produce grains such as dry peas, lentils, beans and chickpeas.

Meanwhile, the U.S. ports were flush with volumes this fall, resulting in some service issues for intermodal. UP recently acknowledged that service, as measured by its trip plan compliance,  could have been better in the third quarter.

The lack of improvement for trip plan compliance for intermodal in the third quarter "really reflected the impact that we've seen across the entire intermodal supply chain and the sharp West Coast volume increase," said UP Chief Financial Officer Jennifer Hamann at the Baird investor conference on Tuesday. "We exited October though with some very good momentum, and in fact, October, we achieved an 83% on-time performance in terms of intermodal trip plan compliance."

Hamann later said the abruptness of the volume rebound contributed to service hiccups in the third quarter. "We had the ability to call back and produce very quickly and did, but it's still you got to restart that engine, and the flows were very imbalanced. And that caused some headaches as well. But when I look at it, and I think about historically, how I think we probably would have handled that quick snap up and down volume versus how we did with our PSR mindset, and with the new agility that our operating team has, I think we did a really fantastic job," she said.

As Blaze looks ahead, one question is the definition of a winner. Does a winner mean growing market share versus growing volumes? Or does it mean shrinking market share but growing in free cash flow?

"We may not know who the winners and losers are, but that's how the game is setting up," Blaze said.

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